Following the Fed meeting I continue to favor owning cheap upside calls in areas of the market that I believe have further upside, while limiting risk in case of a market turn. Along those lines, I wanted to highlight three trades I like the setup for as we head into a new trading week and into Q4:
Buy SPY Oct 582 calls for $2.50 (SPY 568.25 ref)
As expected, implied volatility across the board moved lower after the Fed announcement Wed afternoon. The 1-month (October) at the money SPY vol traded down from about 14 and closed the week at just over 12, which has essentially been the lows for front-month vol since July (upside 25-delta call vol is even lower at ~ 10.75). The argument for owning upside calls in SPY here, besides being cheap on an implied vol basis, is that they continue to trade at a discount to 20-day realized vol (currently ~ 14.60). The market broke out on Thursday above the July/Aug highs and the small pullback on Friday, following the huge jump on Thursday and the disappointing Fedex news, should also be viewed as bullish.
I also like the setup to own upside calls with an October expiry since most/all of the largest tech companies in SPX won’t report earnings until after the Oct 18th expiration. Without the potential for earnings to derail this latest rally, perhaps the market can continue the upside move now that the Fed has started to finally cut rates? Lastly, October has been a much better month for stocks than September with a 2.54% average gain over the last 5 years (vs the 4.46% average decline in September). A rally to new highs to start Q4 certainly doesn’t seem out of the question.
Owning “cheap” upside calls in this tape for the next month gives buyers some flexibility should the market continue its ascent higher. Should we see further gains you can look to lighten up current equity long holdings ahead of earnings and the election (while still maintaining overall long exposure). Otherwise, you can monetize any gains as upside vol is unlikely to go much lower given the already low historical level it currently trades at.
SPY 25-delta 1-month call implied vol continues to trade at a substantial discount to 20-day realized vol
SPY broke out above the July/Aug highs to new all-time highs on Thursday
Buy XBI Oct 105 calls for $1.55 – $1.60 (XBI 101.61 ref)
This trade is a bit more speculative than buying SPY calls, but the risk/reward looks very attractive. The main biotech etf (XBI) has been knocking up against long-term resistance for some time. A breakout above 103-104 should confirm the move higher and will likely bring in more momentum buyers. Much like SPY, implied vol has also been coming in for the XBI upside calls. At a current implied vol ~ 24 that is not only down ~ 10 vol points from the Aug highs, but when XBI was attempting to break out above this level in Feb-March, the 5% upside calls were trading at a vol closer to 30-32.
The Fed cutting rates should also bolster sentiment for the biotechs as they generally benefit from lower short-term rates given their borrowing needs. This trade also aligns with 22V’s current view that the market rally will continue to broaden out. XBI is still down 40% from the 2021 highs, and perhaps some of the money that has gone into the more defensive pharma names will rotate back into this area of healthcare? Lastly, given the more speculative nature of biotechs, I believe we may even see upside call vol move higher on a real breakout for the space (another reason I like the risk/reward to buying XBI upside calls here).
XBI looks poised for a meaningful breakout above the 103-104 level
XBI 1-month 25-delta call vol is down 10 points from the Aug highs and just above the 1-year lows
Buy GLD Nov 255 calls for $2.50 (GLD 242.21 ref)
I mentioned GLD upsides last week but want to reiterate that I strongly favor owning upside calls here thru the election. Gold had another good week last week (up 1.5%) and continues to make new all-time highs on what seems like a daily basis. The US$ index (DXY) is still sitting right above the 2-year lows ~ 100, and perhaps a break below that level could be the catalyst to see a BIG move higher in gold?
What continues to stand out to me is that even with the consistent bid to gold, upside call vol remains “fair to cheap”. Back in April, when GLD spiked from about to 200 to 220, we saw the 2-month 25-delta call vol move up to as much as 20. I think we can see a similar-type move in upside call vol (as gold also moves higher) should gold make that next big move up. I favor the Nov calls since that also captures the upcoming election. These calls can be added to an existing long gold position, or as an upside kicker given how well gold acts, and potential for further highs.
Gold (GLD) closed at another new all-time high on Friday
GLD 2-month 25-delta call vol is still well below the April highs (also when gold was rallying)
The US$ index (DXY) continues to sit just above the 2-year lows
